Your firm is interested in investments and reads in the Treasury Direct that T-Bills are yielding 10%. Your sister, a broker at YXC Securities, advised you to explore either treasury or corporate investments, given the current interest rate premiums. The data she gave is represented in the table : Interest Rates Inflation premium (IP) 6% Maturity risk premium 2% (MRP) Default risk premium for AAA bonds (DRP) Default risk premium for BBB bonds (DRP) Liquidity premium for long-term Treasury bonds (T-bonds) (LP) 3% 4% 1%

Your firm is interested in investments and reads in the Treasury Direct that T-Bills are yielding 10%. Your sister, a broker at YXC Securities, advised you to explore either treasury or corporate investments, given the current interest rate premiums. The data she gave is represented in the table : Interest Rates Inflation premium (IP) 6% Maturity risk premium 2% (MRP) Default risk premium for AAA bonds (DRP) Default risk premium for BBB bonds (DRP) Liquidity premium for long-term Treasury bonds (T-bonds) (LP) 3% 4% 1%

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Question

Your firm is interested in investments and reads in the Treasury Direct that T-Bills are yielding 10%. Your sister, a broker at YXC
Securities, advised you to explore either treasury or corporate investments, given the current interest rate premiums. The data she
gave is represented in the table :
Interest Rates
Inflation premium (IP) 6%
Maturity risk premium 2%
(MRP)
Default risk premium
for AAA bonds (DRP)
Default risk premium
for BBB bonds (DRP)
Liquidity premium for
long-term Treasury
bonds (T-bonds) (LP)
3%
4%
1%

a. Based on the above, what is the real risk-free rate of return?
b. Suppose the expected inflation is constant for the next 5 years; what will be the interest rate for a 5-year Treasury bond?
c. Based on the result from (a), will the interest rate for a 10-year BBB Corporate bond be?

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